Time to get stock-specific

MARKET INSIGHT

It does take a lot more labour than targeting sectors, but that’s the only way out when markets are directionless.

The numbers mentioned in conjunction with the US blowout are huge. The Fannie Mae and Freddie Mac exposures are in the trillions. Lehman has $600 billion in assets, Morgan Stanley has several hundred billion more, AIG slightly less. It’s difficult to tell what the bill will add up to until the bailouts come through and the grisly details are added up.

The impact on India is difficult to assess in quantitative terms, though it’s obviously negative. The initial panic reaction of FII sales and 2000-3000 jobs being lost on Dalal Street is not such a big deal. Finance is a very cyclical industry – jobs are lost every so often.

In the past 9 months, the market has also adjusted to the concept of continuous sales by portfolio investors.

A bear market in itself is not a catastrophe.

A couple of industries could be hit very hard. Indian banks have overseas exposures – they are cagey about how much. The real estate industry was depending on FDI. That will not come through, at least not in the expected timeframes. There has already been a drying up effect noted where private equity flows are concerned. Every listed company with large FII stakes has seen a drastic revaluation.

This is the tip of the iceberg. The really big losses will be the deals that don’t come through in the next couple of years. India’s growth trajectory through the XI Plan (till 2011-12) depends on external investments. Infrastructure alone is expected to swallow upwards of Rs 600,000 crore and roughly three-fourth of that was supposed to come from private funding.

If those investments are not available, GDP growth rates may be revised drastically down. In 2002-03, when the last real recession bottomed out, GDP dipped below 5 per cent. At that time, the Indian investment-consumption mix was skewed about 40:60 in favour of consumption. In 2008-09, it’s more like a 50:50 split so the lack of investible resources could hurt even more.

The other thing is, the Indian economy is now solidly integrated with global trends now. There are no insulated safe-havens any more. This is easily verifiable. Every sector has lost ground in the past fortnight. The highly-leveraged sectors, and the ones dependent on foreign funding have done worse than others. But nobody has done well. It is also difficult to think of an industry that doesn’t have some exposure to overseas trends.

Given that growth is uncertain, this is a value investment scenario rather than one of growth. The valuation fiends will point out that the correction has still not brought prices down to levels where stocks look attractive. Actually given that growth projections are being written down, prices could fall a long way before valuations do become attractive.

The principles that Benjamin Graham laid down during the depression catered to low and uncertain growth projections in the simplest way. Graham assumed growth would be zero and every business that he invested in would go bankrupt. He was only interested in companies that would sell for a higher breakup value than the stock price. That is, the price to book value ratio was 1 or less, in the companies Graham targeted.

During the great depression, perhaps half the US market was available at such valuations. Unfortunately this is not true and never going to be true of a modern, service-oriented economy like India. Book values in India are much more notional and price-book value ratios have usually been in the range 01.7-2 even at market bottoms.

Another way to seek insulation is through the medium of cash-flow analysis. A company with positive cash-flow can support itself. Companies that are cash-flow negative may often be great growth businesses. But they are vulnerable in situations like this where investment dries up.

Unfortunately there are very few Indian businesses that are cash-flow positive either. In some cases, such as with the telecom majors, this is because they have pumped their profits into rolling out new networks in the hope of future growth. In other cases, such as with the PSU refiners, they are cash-flow negative because they are essentially bankrupt.

The few companies that are cash flow-positive are liable to ride out the recession better. You would have to examine stocks on a bottom-up case by case basis. But this could be one metric that outperforms the market.